The coronavirus pandemic and Russo-Ukrainian war have thrust the world onto a path leading to an economic collapse of epic proportions. In this constantly-updated blog we follow the progress of the crisis.
The Stage of the Crisis: The Counterattack/The Flood
Updated 19/05/2022 (previous update 16/04/2021). All updates are presented in bold.
In the December 2018 issue of our Q-Review, we outlined the likely scenarios of an approaching global economic collapse. But, like most things in life, such a dramatic event is unlikely to proceed in a purely linear fashion. There will be different stages within it.
In December 2019 we outlined these stages, which are likely five: the onset, counter-attack, flood, calamity and recovery. Here, we briefly define the characteristics of each, updating them with recent information.
The Onset of the Crisis
In the Q-Review 4/2019, we specified that at the onset, stresses that had been building in the credit markets since the summer of 2019 would explode, shrinking if not eliminating entirely the exits from many parts of that market.
Downgrades of corporate debt in the U.S. and peripheral sovereign debt in the Eurozone would push large fixed-income investors, including pension funds, into higher-rated bonds, which would in turn lead to large-scale selling of lower-rated bonds, forcing wider spreads and even more selling.’
This moment came in late February 2020, when a sudden panic gripped investors in both credit and equity markets after a surge in reported Covid-19 cases and deaths in Italy coincided with the collapse of OPEC talks. Stock markets crashed and spreads in the credit markets exploded. A frantic retreat to ‘safe-haven’ assets, including U.S. Treasuries, German Bunds and U.K. Gilts as well as cash and precious metals commenced.
For a brief period of time in mid-March 2020, we were on the brink of a complete financial market meltdown. Then, as we also had envisaged in December, there was a frantic rush, a Counterattack, on a never-seen-before scale by global and local authorities to rescue the situation.
Currently, we are closing a point of meltdown, again. The mere decision of further interest rate rises and the balance sheet run-off of the Fed (expected soon also from, e.g., the ECB) have pushed asset markets into a ‘tailspin’. This is a development we warned in June/July 2021, when we noted that inflation is likely to be ‘persistent’ rather than ‘transitory’. This time around, however, another Counterattack is likely to be much further down the line.
We envisaged that the second phase of the collapse would be the desperate efforts of authorities to stop the crisis by a counterattack.
We said these were likely to include the restarting and acceleration of QE programs and other market support initiatives, gigantic fiscal stimulus, increasing trade protectionism and possibly even calls for direct debt monetization (see Q-Review 3/2019 for an explanation).
These tactics have been employed in full force. Governments all over the world have pushed vast amounts of debt-financed stimulus into their respective economies. During the spring of 2020 this manifested through both never-before-seen government and central bank support.
There were stimulus packages administered governments across the globe. The Fed effectively became the financial market (see Figure 1) as it backstopped U.S. Treasury markets, intervened in corporate commercial-paper and municipal bond markets and short-term money-markets. Massive support by the FED and the “free money”-schemes of the government levitated U.S. stock market valuations to levels not seen since, at least, the height of the “Tech Boom” in 1999.
China also enacted a massive stimulus programs in March 2020, which were kept running through 2020 (see Figure 2). In 2021, Beijing enacted yet another deleveraging effort. Now, Beijing has communicated that it will start a new “infrastructure push”.
The ECB increased its ‘Pandemic Emergency Purchase Program’ to a €1,850 billion behemoth, and the European leaders reached an agreement on the €750 billion “recovery fund”.
Now, the narrative among central bankers is changing, which spells the end of the Counterattack -phase, for now at least.
While global authorities have been able to uphold the credit and stock markets, thus far, we are now in a likely ‘regime shift’, which is likely to lead to a flood of corporate bankruptcies.
The shift was recently communicated by the Chairman of the Federal Reserve, Jerome Powell, when he stated in a CNBC interview that the Fed will not “hesitate” on its efforts to bring inflation down. ECB President Christine Lagarde iterated in a speech that the “actions that demonstrate our commitment to price stability will be critical to anchor inflation expectations”.
These tell a story of central bankers shifting their focus on supporting the economy on fighting inflation. This spells trouble for the asset and credit markets, but also for the “zombified” global corporate sector.
In December 2019, we asserted that the so-called “zombie” corporations, faced with collapsing global economic demand will start to fail on a scale unseen in decades. Unemployment will skyrocket and tax revenues will collapse.
When the coronavirus erupted in early 2020, leading to lockdowns across the globe, the world economy was confronted by an unexpected and artificial depression. This naturally would have been enough to topple zombie corporations, but the situation was salvaged by massive government stimulus programs and central bank support of enterprises.
Through these measures, the probable evolution of the shock of lockdowns and pandemic into a global banking and economic crisis was stopped. However, the price of these drastic measures, as explained above, was that they created hordes of zombie corporations across the globe. Alas, the zombification problem has, most likely, been exacerbated as a result of these interventions.
For example, according to the data compiled by Deutsche Bank Securities in the U.S., the number of U.S. publicly traded companies classified as zombies has risen to close to 19% by late 2020. By November 2020, U.S. zombie corporations sat on an incomprehensibly large mountain of $2 trillion in debt. The number of publicly listed zombie companies had also swollen by 200 since the start of the pandemic.
At the end of 2018, over 76,000 state-owned enterprises (SOEs) were making a loss and could be classified as zombies in China. This is a stunning figure, because at the end of 2017 China had a total of around 150,000 SEOs.
Incredibly, around 50% of China’s SOEs were likely to be zombies, even before the bailout operations during the pandemic. While China let 6 percent of all companies fail during the first half of 2020, this constitutes only a marginal reduction in the zombification problem, which is likely to have continued to grow during the latter part of 2020 and into early 2021.
Alas, the zombification of the global corporate sector was already widespread and accelerating before the pandemic. With massive government bailouts and overwhelming central bank meddling during the pandemic, the world economy is now likely awash with zombie corporations.
All that is needed to start the Flood, is a bigger shock, which arrived in Summer 2021.
The Inflation Shock
There have been reports of serious bottlenecks in the transport of vast quantities of commodities, which has lifted prices. So, inflation has been running higher than shown in the official figures, but the real problems are likely to emerge when economies re-open and conditions move towards a “new normal”, which is now occurring in the U.S. Airlines, hotels, restaurants, etc., now have diminished capacity, which means that they may be unable to meet suddenly increased demand. And the prices for services may see a sudden uptick which, combined with the already fast-increasing price of commodities, could lead to an abrupt and unexpected rise in the inflation rate when economies are operating more fully.
In the U.S. inflation pressures are transferring from “want to have” products, like lumber, to “need to have“ like food, rents and fertilizers. This is likely to manifest to increased wage pressures, because everyone will notice that the purchasing power of their wages are declining. If wage pressures increase, inflation expectations increase and this will translate into higher wages and prices set by corporations fuelling faster inflation, long-term. Presently there are also serious bottlenecks in supply, such as hiring difficulties, creating inflation pressures.
Inflation, expectedly, did not come down and by the end of 2021, the rhetoric among central bankers, especially in the Fed, started to change. Then came the Russo-Ukrainian war, which delivered another inflation shock.
We are now in a situation, where central bankers are basically forced to rise rates and start to withdraw ‘articial liquidity’ from the financial markets through programs of quantitative tightening. Like we warned at the start of the first round of QT:s, in March 2018, they will bring down the heavily inflated asset markets, and, combined with the interest rate rise, also the economy.
The end-result will be an utter economic collapse, Calamity.
We are likely to first head into a stagflation, where economy stalls, while inflation runs rampant. It will be a ‘double-whammy’ to the highly indebted corporate sector. Demand will vanish, while price uncertainty and higher interest rates cause wide-reaching defaults across the global corporate sector. This will lead to an ugly chain of bank and corporate failures. Global liquidity will collapse and stock markets will crash in a spectacular fashion.
The value of the holdings of public and private pension funds, charitable endowments, bank trust funds, insurance company general and variable accounts, and stock and bond mutual funds will crash in short order in the Flood. Even lowly money-market funds may be at risk, just as they were in the 2008 financial crisis.
Due to both crashing capital markets and banking sector bankruptcies, joblessness and poverty are likely to explode. Simultaneously, government tax revenues will collapse as incomes retreat and capital gains evaporate.
As governments spending skyrockets in an orgy of Keynesian counter-cyclicality, national deficits will hit all-time highs on both an absolute and relative basis. A spree of sovereign defaults will rock the capital markets.
Governments will try to save critically-important banks, which will require large-scale funding many countries—such as those in the Eurozone—cannot afford and will not be able to finance in paralyzed capital markets. This economic reality makes depositor bail-ins the only, if politically-unpalatable, option.
Confronted by new and harsh fiscal realities, pensions and other social security programs are likely to face serious cutbacks, by desperate governments. An economic calamity sets in.
However, even grimmer scenario exists, because two of the main drivers of fast or even runaway inflation have started to emerge:
- Excessive growth of money in circulation
- A broad reduction in productive capacity
The balance sheet of central banks has swollen during the past year due to the aforementioned QE programs.
Production capacities may be hampered by forces that push companies into bankruptcy. One of the most historically common and pernicious is war, such as the Great War which contributed to the hyperinflation in the Weimar Republic between 1919-1924, or the economic crash caused by the collapse of the ruling Communist political system, which preceded the Russian hyperinflation in the early 1990s.
Now, Europe is at war, which is hampering supply chains and commodity deliveries across the globe. Moreover, production capacity can become even more severely restrained due to the likely large-scale failures of zombified corporations.
Extreme inflation episodes can be stopped only by abruptly curtailing the flow of credit into the economy, and possibly by changing the currency used within the country concerned.
There is also a risk that the Eurozone will unravel in the face of rising interest rates and the rolling back of support (QE) programs of the ECB. This would create a currency crisis of epic proportions.
In any case, an outright economic calamity with serious degradation of living standards is likely to follow.
If the full socialization of our economies and financial markets does not occur, we expect the global depression to last 3-5 years. The initial collapse is likely to be over within three years (2022-2024).
The path to recovery will depend crucially on how far the ‘cleansing’ of the economy, markets and financial sector is allowed to go. If the banking sector implodes completely, the economic deficit will naturally be made much deeper leading to a systemic crisis.
However, if the essential functions of the banking sector are sustained, especially in Europe, we could avoid the deepest malaise. Moreover, if unsound banks and “zombie” corporations are allowed to go under or are wound-down methodically, it will clear much of the malinvestment from the economy, creating the foundation for a strong and sustained recovery.
So, if we manage to return to the principles of the market economy including, most crucially, a return to undistorted price discovery in the capital markets, we are likely to see one of the most powerful recoveries in global economic history. It would be led by robotization and general technological innovation, which hard economic times tend to foster.
Additionally, debt monetization, helicopter drops, CBDC, and other money-conjuring and take-over schemes would corrupt the economy, further making a sustained recovery impossible (see more from Q-Review 12/2020). This is something we may face deeper in the crisis, as authorities are likely to panic.
Moreover, with the governments and the central banks assuming a much bigger role in the economy and society in this darker scenario, some form of fascism (which is, by definition, the merger of state and corporate power) would be the likely end-result of these developments.
We can do nothing more than hope that wise, courageous and far-sighted political leadership will spare us from that horrible fate.
We are closing the ‘endgame’
Following the coronavirus outbreak, junk bond yield-spreads shot-up. They were tamed by massive support operations launched by the Fed, which also pushed stock markets to new heights. Now, they are rising rapidly (see Figure 3).
We are entering into a very interesting, but most likely a very painful era in the economic history of the world.
Central banks are pulling back their unprecedented monetary support measures, while the world is grabbling with first war of invasion in Europe since 1945. There’s also a threat of a new mutations of the Coronavirus leading possibly to renewed lockdowns across the globe. We are also facing the threat of a global food crisis in 2023/2024.
Uncertainty in the world has probably not been higher since the Second World War. We are helping people and corporations cope with the uncertainty in our Crisis Preparation -series, where we will soon publish an inflation -update.
Learn how to prepare and survive from the economic collapse with the help of our Crisis Preparation -reports, which are now included into the Annual Subscription of the Q-Review (till the year-end).
We monitor the path of the crisis closely in our Deprcon -service, which includes event-related alerts on developments threatening the markets. The one-year subscription of the service is available fromGnS Store